China's $6.5 trillion rally: stock-market history

A rally that’s gone too far, too fast for $6.5 trillion, the value created in just 12 months of trading on Chinese stock exchanges. As China’s boom surpasses the headiest days of the U.S. Internet bubble, signs of excess are everywhere. Mainland speculators have borrowed a record $348 billion to bet on further gains, novice investors are piling into shares at an unprecedented pace and price-to-earnings ratios have climbed to the highest levels in five years. The economy, meanwhile, is mired in its weakest expansion since 1990.

“We have a wonderful bubble on our hands,” said Michael Every, the head of financial markets research at Rabobank International in Hong Kong. “Of course, there’s short-term money to be made. But I fear it will not end well.”

Chinese shares face their next big test on Tuesday, when MSCI Inc. decides whether mainland securities are eligible for indexes used by $9.5 trillion of funds worldwide. An endorsement would signal global acceptance for equities that had been off limits to overseas money managers for much of their 25-year history.

While no other stock market has grown this much in dollar terms over a 12-month period, previous booms have arguably had a greater impact when adjusted for purchasing power and the size of economic output at the time.

1929 Crash:
At the height of Japan’s rally in 1989, for example, the nation’s market capitalization reached 145 percent of gross domestic product, versus an estimated 87 percent in China today, according to data from the World Bank and International Monetary Fund. The Dow Jones Industrial Average climbed for five straight years in the run-up to the crash of 1929, adding more than 200 percent.

On top of price appreciation, China’s $9.7 trillion market is getting a boost from a wave of new share sales. Mainland companies have raised at least $56 billion this year, according to data compiled by Bloomberg.

Optimists are betting China’s Communist Party leaders will keep the rally going to help even more companies tap the stock market for fresh capital. Debt levels for Shanghai Composite Index companies reached the highest since at least 2005 in January.

People’s Bank of China Governor Zhou Xiaochuan, who cut interest rates three times since November, has supported equity investment as a way to bolster the economy. The Shanghai-Hong Kong exchange link, started at the end of last year, gives global money managers unprecedented access to mainland shares.

Earnings Slump:“If the government endorses a rally, it will go up,” said Nicholas Yeo, the Hong Kong-based head of Chinese equities at Aberdeen Asset Management, which oversees about $491 billion worldwide.

Of course, a flood of new shares runs the risk of overwhelming demand, especially now that valuations have climbed to the highest levels since 2009. At 19 times projected earnings, the Shanghai Composite is 62 percent more expensive than the MSCI Emerging Markets Index.

Profits in the Chinese gauge trailed analyst estimates by the most in six years in 2014 as the nation’s economic growth slumped to 7.4 percent, the slowest pace in more than two decades. In the latest sign of weakness, data on Monday showed a 18.1 percent plunge in imports for May and a third straight month of falling overseas shipments.

So far, none of that has stopped mainland investors from pouring money into stocks.

They opened a record 4.4 million new trading accounts in the final week of May, while margin debt on the Shanghai exchange climbed to a record on June 5. Chinese shares surged on Monday, sending the benchmark index up 2.2 percent to a seven- year high.

For Rabobank’s Every, it’s only a matter of time before the market falls back down to earth.

“Too many people are making too much money, too fast,” he said. “It’s greed, fear of missing out, and willingness to suspend belief.”

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Vernon Joseph Go is a Corporate Mad Hatter passionate about learning, technology, simplified finance as well as Inclusive Businesses through Social Entre/Intrapreneurship Development by bridging purpose and profit.